Friday, April 17, 2009
Forex: Wading Into The Currency Market
by Kathy Lien,
Whenever you devote money to trading, it is important to take it seriously. For traders who are getting into the forex (FX) market for the first time, it basically means starting from square one. But new traders don't have to be left in the dark when it comes to learning to trade currencies; unlike with some of the other markets, there is a variety of free learning tools and resources available to light the way. You can become FX-savvy with the help of virtual demo accounts, mentoring services, online courses, print and online resources, signal services and charts. With so much to choose from, the question you're most likely to ask is, "Where do I start?" Here we cover the preliminary steps you need to take to find your footing in the FX market.
Finding a Broker
The first step is to pick a market maker with which to trade. Some are larger than others, some have tighter spreads and others offer additional bells and whistles. Each market maker has its own advantages and disadvantages, but here are some of the key questions to ask when doing your due diligence:
Where is the FX market maker incorporated? Is it in a country such as the U.S. or the U.K., or is it offshore?
Is the FX market maker regulated? If so, in how many countries?
How large is the market maker? How much excess capital does it have? How many employees?
Does the market maker have 24-hour telephone support?
In order to ensure that the money you are sending will be safe and that you have a jurisdiction to appeal to in the event of a bankruptcy, you want to find a large market maker that is regulated in at least one or two major countries. Furthermore, the larger the market maker, the more resources it can put toward making sure that its trading platforms and servers remain stable and do not crash when the market becomes very active. Third, you want a market maker with a larger number of employees so that you can place a trade over the phone without having to worry about getting a busy signal. Bottom line, you want to find someone legitimate to trade with and avoid a bucket shop. (For related reading, see Understanding Dishonest Broker Tactics.)
Checking Their Stats
In the U.S., all registered futures commission merchants (FCMs) are required to meet strict financial standards, including capital adequacy requirements, and are required to submit monthly financial reports to regulators. You can visit the website of the Commodity Futures Trading Commission (an independent agency of the U.S. government) to access the latest financial statements of all registered FCMs in the U.S.
Another advantage of dealing with a registered FCM is greater transparency of business practices. The National Futures Association keeps records of all formal proceedings against FCMs, and traders can find out if the firm has had any serious problems with clients or regulators by checking the NFA's Background Affiliation Status Information Center (BASIC) online.
Once you've found a broker, the next step is to test drive its software by opening a demo account. The availability of demo or virtual trading accounts is something unique to this market and one that you'll want to exploit to your advantage. Your goal is to learn how to use the trading platform and, while you're doing that, to find the trading platform that suits you best. Most demo accounts have exactly the same functionalities as live accounts, with real-time market prices. The only difference, of course, is that you are not trading with real money.
Demo trading allows you not only to make sure that you fully understand how to use the trading platform, but also to practice some trading strategies and to make money in the paper account before you move on to a live account funded with real money. In other words, it gives you a chance to get a feel for the FX market. (To learn more, see Demo Before You Dive In.)
Do Your Research
When you trade, you never want to trade impulsively. You need to be able to justify your trades, and the way to find justification is by doing your research. There are many books, newspapers and other publications with information about trading the FX market. When choosing a source to consult, make sure it covers:
The basics of the FX market
Key fundamental news and events
Because the FX market is primarily a technically driven market, the best book that you can read as a new trader is one on technical analysis. The better you get at technical analysis, the better you can trade the FX market from a speculative perspective. (For further reading, see our Introduction To Technical Analysis.)
When it comes to newspapers, seasoned foreign exchange traders typically refer to the Financial Times and the Wall Street Journal simply because they contain international news. Trading FX involves looking beyond mere economics, since politics and geopolitical risks can also affect a currency's trading behavior. Therefore, it's also important to keep up with major non-financial news sources such as the International Herald Tribune and the BBC (online, on TV or on the radio) for the big stories of the day.
One of the most popular magazines among FX traders is the Economist, because it covers many macro themes; however, currency-specific and trading magazines are also popular.
Once you have a solid foundation in FX trading, you need to keep up to date on daily fundamental and technical developments in the FX market. A variety of free FX-specific research websites, which can be found easily on the internet, will do the trick.
Education and Mentoring Programs - Are They Worth It?
The benefit of online or live courses over books, newspapers and magazines is that you can get answers to the questions that perplex you. Hearing or seeing other people's questions is also extremely valuable, since no one person can think of every possible question. In a classroom setting, either online or live, you can learn from the experiences and frustrations of others. As for a mentor, he or she can draw on personal experience and hopefully teach you to avoid the mistakes he or she has made in the past, saving you both time and money.
What About Trading Systems and Signals?
Many traders wonder whether it is worthwhile to buy into a system or a signal package. Systems and signals fall into three general categories depending on their methodology: trend, range or fundamental. Fundamental systems are very rare in the FX market; they are mostly used by large hedge funds or banks because they are very long term in nature and do not give many trading signals. The systems that are available to individual traders are typically trend systems or range systems - rarely will you get one system that is able to exploit both markets, because if you do, then you have pretty much found the holy grail of trading.
Even the largest hedge funds in the world are still looking for the switch that can identify whether they are in a trend or a range-bound market. Most large hedge funds tend to be trend following, which is why hedge funds as a group did so poorly in 2004, when the market was trapped in a tight trading range. Range-bound systems will only perform well in range-bound markets, while trend systems will make money in trending markets and lose money in range-bound markets. So, when you buy into a system or a signal provider, you should try to find out whether the signals are mostly range-bound signals or trend signals. This way you can know when to take the signals and when to avoid them. (To learn more, see Identifying Trending & Range-Bound Currencies.)
Trading Setups - Finding What Works Best for You
Every trader is different, but the best trading style is probably a combination of both technical and fundamental analysis. Fundamentals can easily throw off technicals, while technicals can explain movements that fundamentals cannot. Smart traders will always be aware of the broader fundamental picture while using their technicals to pinpoint good entry and exit levels; combining both will keep you out of as many bad trades as possible, and it works for both day traders and swing traders. Most free charting packages have everything that a new trader needs, and many trading platforms offer real-time news feeds to keep you up to date on economic news. (For further reading, see Devising A Medium-Term Forex Trading Strategy.)
Learning to trade in the FX market can seem like a daunting task when you're just starting out, but thanks to the many practical and educational resources available to the individual trader, it is not impossible. Learning as much as possible before you put actual money at risk should be at the forefront of your agenda. Print and online publications, trading magazines, personal mentors, online demo accounts and more can all act as invaluable guides on your journey into currency trading.
Good investing, Kingsley.